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Under New York Stock Exchange and the NASDAQ Stock Exchange rules that were approved by the Securities and Exchange Commission (SEC) in January of this year, companies listed on those exchanges must comply by July 1, 2013 with new independence requirements for compensation committee advisers. Specifically, by July 1, 2013, compensation committees must:

  • Have authority to retain compensation consultants, legal counsel and other compensation advisers,
  • Have authority to pay reasonable compensation to such advisers with funds provided by the company, and
  • Have the responsibility to consider independence factors before selecting such advisers.

These requirements originated with the Dodd-Frank Act in 2010 and have been making their way through the regulatory process since then.

There are a number of exemptions from these rules, but if you sit on the board of a company listed on one of the major stock exchanges, or if you are a senior executive of one of those companies, you are probably already familiar with these new rules and any applicable exemptions.

Other important changes, including independence requirements for directors sitting on the compensation committee, will be effective as of the date of the first annual meeting after January 15, 2014 (or October 31, 2014, if earlier). Most listed companies will also be required to have a formal written compensation committee charter reflecting these independence rules in effect by that date.

In view of the July 1, 2013 deadline that applies to the compensation committee’s ability to retain, pay and assess the independence of its advisers, the compensation committee’s charter should be modified by that earlier date, or some other interim, and written corporate action should be taken to provide the committee with the necessary authority.

Adviser independence -- Six factors

Under the rules that are effective on July 1, 2013, compensation committees may select a compensation consultant, legal counsel or other adviser, only after taking into consideration the following six factors: 

  1. The provision of other services to the company by the firm that employs the compensation consultants, legal counsel or other advisers, who will be advising the committee;
  2. The amount of fees received from the company by the firm that employs such adviser as a percentage of the total revenue of the firm;
  3. The policies and procedures of the firm that employs the advisers that are designed to prevent conflicts of interest;
  4. Any business or personal relationship of an adviser with a member of the compensation committee;
  5. Whether any stock of the company is owned by the advisers; and
  6. Any business or personal relationship of the advisers or the firm employing the adviser with an executive officer of the company.

The compensation committee of a listed company is required to conduct the independence assessment with respect to any compensation consultant, legal adviser or other adviser, other than in-house legal counsel, that provides advice to the compensation committee.

In effect, the requirement to assess advisers is not limited to advisers retained by the compensation committee. These rules will require the compensation committee to assess the independence of outside legal counsel or compensation consultants or other advisers retained by management or by the company that provide advice to the compensation committee. Only in-house legal counsel is exempted from the independence assessment requirement.

Significantly, these rules do not require compensation committees to retain advisers, or to retain only independent advisers. The rules require only that compensation committees conduct the assessment of adviser independence. In fact, the rules include express statements to the effect that compensation committees are free to retain any adviser, including advisers who are not independent, after assessing the adviser’s independence using the enumerated factors.

The SEC has indicated it expects listed companies to conduct the independent assessment of its advisers at least annually.

Disclosure requirement expanded

Under existing disclosure rules regarding executive compensation, listed companies are required to include a description of the process and procedures used in the consideration and determination of executive and director compensation, including disclosing any role played by compensation consultants. Effective as of January 1 of this year, listed companies are required to expand on that disclosure to indicate whether the use of a compensation consultant has resulted in a conflict of interest, the nature of the conflict of interest, and how the conflict is being addressed. The SEC regulations indicate that the same six factors enumerated above should be used to determine whether a compensation consultant has a conflict of interest. This disclosure rule applies to compensation consultants and not to legal counsel or other advisers.

In drafting its rules on the assessment of the independence of compensation consultants, legal counsel and other advisers, the SEC declined to include any materiality, numerical or other thresholds that would narrow the circumstances in which a compensation committee would be required to consider the independence factors specified. All the facts and circumstances relevant to the six factors should be presented to the compensation committee for its consideration. The SEC has also chosen not to define the phrases “provision of other services” or “business or personal relationship.” In effect, the SEC is encouraging compensation committees to closely scrutinize the compensation consultants, legal counsel, and other advisers who give advice to the committee and has stated, “the factors should be considered in their totality and that no one factor should be viewed as a determinative factor of independence.”

As is obvious from a quick review of the six independence factors that must be considered, compensation committees will need to collect information from their current and prospective advisers in order to comply with the assessment requirement.

Has your committee engaged counsel to assist with the collection and assessment of that information, and is that counsel independent?

For more information, please contact:

Michael G. Riley

Large and small employers need to attract, motivate and retain executive talent. We help clients deal with their most valuable assets: their key executives. This may involve advising entrepreneurs and start-up companies about structuring business entities to create equity incentives, or advising compensation committees of public companies regarding best practices and compliance in the rapidly developing area of non-qualified deferred compensation or executive compensation proxy reporting.